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of rate differentials.16

The body of academic research regarding insurance market competitiveness focuses nearly exclusively on examining whether there is competition on the supply side of the equations and either ignores the impact of aggregate demand of the model or assumes that aggregate demand is a normal, downward-sloping demand function. Consumer demand curves are based upon consumers maximizing satisfaction through their tastes, prices of the good and other goods, and income.17 In the cases of automobile and homeowners insurance, where such coverage for many people is a compulsory purchase, it is possible that an efficient market-clearing price may not be able to be established in a competitive free market because consumers are required to purchase the insurance, have no other product offerings to consider and in many cases are not able to effectively consider the price of the insurance product because of incomplete information about the insurance product.

The existence of a kinked demand curve may exist within other industries as there are other products that are near-necessities. Education and automobiles are near-necessities and health care and food are absolute necessities. The extent of substitutes for these goods can be debated and the proper distribution system varies for these goods. For instance, vehicles may be best served in an unregulated market while education and health care may work best in a regulated or government-controlled market. If a market cannot efficiently provide near-necessities, there is a continuum of possible options available to deal with this shortcoming, such as charities, vouchers, subsidies or government control of prices or inputs. All of these options should be explored in order to determine the most efficient allocation of resources.

In addition, although some insurance products are mandated purchases for some consumers, we do not know the degree to which consumers would buy the insurance products on their own. One example of consumers not buying an insurance product is with renters insurance but it is not known whether consumers do not buy the product because they do not wish to or because they believe they are covered under another policy, such as the building owner’s policy. Flood insurance is also not frequently purchased. It is not intuitive whether the mandatory purchase of an insurance policy, such as flood insurance, would fundamentally change the demand curve and require regulation. It does seem likely that most consumers would probably purchase at least basic homeowners and automobile insurance even if not required to do so. Also, most consumers purchase more than the minimum mandated amounts when required to buy insurance. Consumers have a desire to protect their assets regardless of any mandate to purchase insurance. This fact calls into question the existence and effect of the kinked demand curve. More research would need to be done on consumer preferences and the nature of consumer demand for insurance in order to develop a more precise model of the kinked demand curve.

Social Welfare Aspects of Personal Lines Insurance

There are some important considerations regulators must be aware of in order to understand the appropriate market structure, particularly when the competitive assumptions discussed previously are not completely present. A key result of efficient competitive markets is that the efficient exchange of goods and services is established and neither buyers nor sellers can be made better off without making the other party worse off. If one of the competitive assumptions is violated, there is likely a way to make some consumers better off without harming others.18

Insurance fills a unique societal role by not only protecting the purchasing consumer from financial ruin but also protecting other drivers in the event of an auto accident or, in the case of homeowners insurance, protecting the community as a whole in the event of a widespread catastrophic event. The importance of insurance and its role to society is clear.  For these reasons regulators are cognizant of balancing the social good that is insurance with the goals of profit-maximizing insurers. Oftentimes, profit-maximization and the social good are at odds. Within certain geographical areas, or sometimes for policyholders with characteristics correlated with higher risk of loss, high prices and low availability may call the existence of a vibrant, competitive market into question. These situations present challenges to regulators who, like consumers and insurers, desire a market that is properly functioning.  A properly functioning market will be characterized by widespread availability and, to the extent that higher losses and/or lower policyholder income make standard insurance products difficult to afford, the marketplace will respond with fairly priced products designed to provide more basic, yet still sufficient and appropriate coverage.  An example of such a product might be a private passenger auto policy with reduced premiums for policyholders with very low annual mileage.  

As seen above, competitive market theory holds that consumers have the relevant information necessary to purchase an appropriate product at a competitive price, including the decision not to purchase a good or service or to purchase a

16 Ippolito, R. (1979) “The Effects of Price Regulation in the Automobile Insurance Industry,” Journal of Law and Economics 22 (1): 55–89.

17 Hanson, Dineen and Johnson (1974, p. 112).

18 Hanson, Dineen and Johnson (1974, p. 132).

© 2009 National Association of Insurance Commissioners 9

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